First Capital predicts 300 bps policy rate hike

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With inflation nearing 100 per cent, while the policy rate is a mere 14.5 per cent, gives more than enough space for policy rates to be jacked up by 100 per cent to 29 per cent, when Central Bank of Sri Lanka’s (CBSL’s) Monetary Board meets once more to set policy rates today (6).

With the Government of Sri Lanka (GoSL)/CBSL capping the benchmark ‘spot’ at +/- three per cent on Rs 360/365 to the US dollar in two-way quotes not having the desired result of upping remittances inflows, the country’s highest foreign exchange earner, through official channels, a counter to an overvalued, administered exchange rate is to have in place a high interest rate regime to attract inflows into the domestic fixed income market, as a salve to Sri Lanka’s dollar crisis.

Premier Ranil Wickremesinghe speaking in Parliament yesterday hinted of a possibility of a rate hike today by saying that the current high inflation has eaten up to 50 per cent of EPF savings. The Premier further pointed out that this inflation was mainly imported led by a weak rupee.

Almost subscribing to this viewpoints, First Capital, in a report dated Friday (1 July) said, “As per our view, at the upcoming policy meeting, there is a robust case for an increase in policy rates to compensate for heightened political risk and thus to preserve the currency and foreign reserves.

As a result, we believe there is a higher probability of 60 per cent for a hike to iron out the prevailing imbalances in the domestic financial markets and the external sector of the economy, while preempting the build-up of any excessive inflationary pressures over the medium term, thereby supporting macroeconomic stability.

Considering recent developments and higher interest rate expectations by market participants as reflected at previous Treasury (T) bill and T bond auctions, there is a greater prospect that CBSL might opt to go for a fairly large increase in policy rates such as 300 basis points (bps). However, there is also a lower probability of 40 per cent to maintain the policy rates at its current level to improve the high frequency indicators.”

By Paneetha Ameresekere